Retirement

Cash-balance pension plans are growing fast

BOSTON (MarketWatch) -- As retirement plans go, cash-balance plans aren't as well known nor as widely discussed as 401(k)s. Nor are they in a state of decline as are traditional defined-benefit pension plans. Instead, cash-balance retirement plans are in-between: small, but growing fast.

There were about 4,797 cash-balance plans active in 2007, versus 44,000 defined-benefit plans and 659,000 defined-contribution plans, according to the U.S. Labor Department's Employee Benefits Security Administration. Read that report.

But the number of cash balance plans has grown 259% since 2001, when there were just 1,337 plans in existence, according to Kravitz, a retirement-plan consultant.

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And though small by comparison to other types of plans, the number of participants -- and assets -- in cash-balance plans is not insignificant. There are 10.5 million workers in such plans, with $777 billion in assets. By contrast, there are 42 million participants in defined-benefit plans, with $2.6 trillion in assets, and 81 million participants in defined-contribution plans with $3.4 trillion.

So what do those 10.5 million workers need to know about what the plans they're in?

A type of defined-benefit plan

For starters, participants should know that cash-balance plans are a form of defined-benefit plan, said Jerry Levy, a partner in Mercer's retirement, risk and finance business.

As with defined-benefit plans, participants are guaranteed a certain amount of money when they reach normal retirement age, and the participant gets to choose from one of three distribution options when they reach that age: a lump sum, a single-life annuity or a joint-and-survivor annuity.

As with traditional defined-benefit plans, cash-balance plans are backed by the Pension Benefit Guaranty Corporation, the quasi-government agency that is often referred to as the insurer of last resort for defined-benefit pension plans. So, if the participant's employer goes belly up, the PBGC will pay the participant his or her pension, up to the legal limits.

Interest credits

And as with traditional defined-benefit plans, the employer -- not the employee -- bears the investment risk. Here's how it works: The employer invests the money on behalf of the participant however they so choose, in stocks, bonds and the like. But the employer also establishes a guaranteed rate at which the participant's money will grow by, say 4%, 6% or 8%. (The rate is usually tied to the yield on the 10-year U.S. Treasury bond, but in some cases it might be tied to a corporate bond index.)

Each year, the worker gets a statement that details the value of their cash-balance plan. Participants in these plans should ask their employer what the interest credit rate is. The higher the rate, the better for the worker, said Mike Archer of Towers Watson.

The really good news about these plans: Unlike defined-contribution plans, the value of cash-balance plans typically never goes down. And given what happened to the stock market over the 10 years ended 2009, that's likely a plus for some.

Funded status

As with other defined-benefit plans, participants in cash-balance plans also need to check on whether the plan has the money to meet its obligations; the experts call this the plan's funded status. Plans that are fully funded can pay off 100% of the money owed participants. (There's a nuance regarding account value and the actual pay-off amount, but that's best left for the actuaries.)

By law, these plans have to be fully funded over a 7-year period. Also of note, typically participants are fully vested in these plans after three years of employment. You can review the funded status by checking the company's Form 5500 filing with the Labor Department.

Contribution rates

As with defined-benefit plans, the employer contributes money into the plan on the worker's behalf -- typically about 2% to 5% of the worker's salary though in some cases the percent is tiered (based on years of employment) and might go as high as 8%.

401(k) plans and cash-balance plans

If you're lucky enough to have a 401(k) plan and a cash-balance plan, you might want to consider investing your 401(k) a bit differently than if you just had a 401(k). The money in the cash-balance plan is in essence a fixed-income security.

Thus, if you had $100,000 in your cash-balance plan and your 401(k) plan, and your investment policy statement suggested an asset allocation of 50% stocks and 50% bonds, then - in broad brush strokes - you might consider investing your entire 401(k) plan in equities. Investing is, of course, a bit trickier than that. You need to consider the value of your Social Security benefits, taxable accounts, and the like before deciding how to divvy up your assets. But in the main, think of the money in your cash-balance plan as fixed income.

Distributions

When it comes time to take the money from your cash-balance plan, you have the same options as with other defined-benefit plans. And two of those options - the single life annuity and the joint-and-survivor annuity - might have some appeal for those who fear outliving their assets or for those who don't want to bear the investment risk, said Levy.

In short, the annuities provided by the employer don't have any of the expenses of annuities purchased in the open market. Instead, these annuities are created by the employer and the payouts are determined by government laws and rules.

Of course, deciding whether to take a lump sum or an annuity from a cash-balance plan can't be done in a vacuum. If you already have many sources of fixed income to pay for your retirement expenses, you might consider taking the lump sum. But if you don't have any sources of fixed income, the annuity option might be the better choice.

Great for small- to mid-sized firms

Small- to mid-sized firms that offer 401(k) plans but have reached the legal limits to which highly compensated executives or owners can contribute might consider adding a cash-balance plan. According to Archer, those firms can add such a plan and provide a larger combined pension benefit to workers in doing so.

Bad press

To be fair, cash balance plans have had their share of bad press in recent years. Indeed, many employers have fielded age-discrimination lawsuits when converting traditional defined-benefit pension plans into cash-balance plans.

In the main, however, the experts seem to agree that the bad news is behind us and if "cash-balance plan" isn't a household phrase just yet, it's certain to become one in time.

Robert Powell has been a journalist covering personal-finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News. Powell is the editor of Retirement Weekly. Learn more about Retirement Weekly at this Web site.

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